$5.00 Gas is Coming. Three myths, one fact.

 In Inside FleetCarma

[Canadian readers: the average gas price in Toronto as I write this is 133.5 cents/L. Using the US gallon, that’s $5.05/gallon. By comparison the average price in Atlanta is $3.50/gallon. Since my $5/gallon refers to US gas prices, the proportional Toronto price would be 188.5 cents/L. And about $2/L for you Vancouverites. Please read accordingly.]

Gas Price Stations Pictures Over Time

Atlanta gas prices in January 2009 and August 2013. $5 gas is coming.

It was February 28, 2012 . I was in a council briefing room, reporting to an executive council on an electric vehicle roll-out plan that we had supported our client in developing. And then came my least favorite question.

“How will your plan work when gas prices go down? Because that is where they are going.”

The answer I provided was simple, the FleetCarma Total Cost of Ownership system enables you to dial in your gas price estimates, and the analysis automatically responds. Inside my mind, all I heard were nails screeching along a chalkboard.

That question frustrates me, and probably unreasonably so. To my defense, that question is usually more of a statement than question and is frequently asked by someone who read a single article on the Bakken being the Saudi of Dakota. Or by someone using a 5 cent reduction at the pump as proof of a cheap gas for the next decade.

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Polite answer aside, here is my actual answer: Gas prices, over time, will rise. Period. There is one single explanation of why. First though, we should quickly cover three common arguments used to support cheap gas and why they are flawed.

Argument #1: Cheap Gas Because of Efficient Cars

“Since the average fuel efficiency of the new car sold in 2025 will be over 50mpg gas demand will sharply decline reducing gas prices”.

It is true that new cars, by law, are becoming significantly more efficient. This is fantastic news. Our CrossChasm Consulting division is working with multiple automakers to help them with their new designs. If we assume new standards will be met (more on this later), the average new car sold in 2025 will indeed have a sticker fuel economy above 54mpg. The actual real-world fuel economy will be significant less than 54mpg, regardless they will be significantly more efficient than today.

So why won’t this mean cheap gas? [click to the next page to find out]

Two reasons.

First, the average model-year on the road in 2025 will actually be a MY2014 vehicle. Why? The average age of a car or truck on U.S. roads recently hit a new all-time high of 11.4 years . That number may move slightly, but the core point is that the effects of standards take time to have an impact. The vehicle fleet has massive “inertia” and it takes at least decade for the effects of new standards to be felt. The standards will have an impact, but the impact will be gradual and take time to see.

US Crude Oil Consumption & Global Oil Price

US Crude Oil Consumption & Crude Oil Prices from 2005-2013

Second, is that for the ‘efficient cars’ to be true, a decline in North American energy demand needs to cause a reduction in crude oil prices. What many people may not have realized, is that US demand has already been going down, and gas prices have only risen. US demand has gone down by about 10% in the last 8 years, and at the same time, crude oil prices have doubled.

At right is a plot of crude oil prices and US demand/consumption over the past 8 years using EIA numbers. The US demand has gone DOWN from 20.8 to 18.7 million barrels per day. Using the West Texas price, the price of crude has RISEN from $57/barrel to $107/barrel over the same time. Using the Brent (European) price, the rise has even more, from $55 to $111.

What this plot clearly shows, is that prices of oil have continued to rise while US demand has dropped. Only significant and rapid declines in demand (as seen during the recession) can have a notable impact on crude oil prices. As said above, the fuel efficiency gains will only be gradual. US Demand would have to basically fall off a cliff to cause a significant reduction in price, and this reduction would be beyond any reasonable estimate.

Conclusion: MYTH. Efficient cars will abate US fuel demand but won’t be large or quick enough to make gas cheap.

Argument #2: Cheap Gas Because Technology Will Get More Out of the Ground (ie. the Bakken)

“The Bakken was first discovered in the 50s, but only became technically recoverable in the last 15 years because of new technology. Resources now recoverable will flood the oil market”.

The Bakken is one of the largest deposits of oil and natural gas in the US, the formation is found under Montana, North Dakota, Saskatchewan and Manitoba. The Bakken is fantastic news for U.S. energy independence and the economy. Thanks to new technology we can now financially produce these reserves. Even better so, this could be the biggest increase in producible reserves over the last 30-40 years.

Here’s the reality check though. The amount of producible reserves in the Bakken is somewhere between 2.1 billion barrels and 20 billion barrels (it is a hotly contested number). The question becomes, how much is that in terms of global oil demand? Between 1 and 7 months of global oil demand. The actual production of the Bakken’s reserves will be gradual and span decades, but what I am highlighting is that the “most significant increase in 30-40 years” bought us the equivalent of between 1 and 7 months of global demand. Not years. Not decades. Months.

Conclusion: MYTH. Recovery technology will improve and enable more development of existing reserves, however, even in the best cases these only add months to the world’s oil supply. Not nearly enough to enable cheap gas.

Argument #3: Cheap Gas Because of New Discoveries of Oil

“We’re always finding new oil reserves, and this will outpace our demand”.

This isn’t true. Yes, oil exploration efforts are always uncovering new resources, but in the past few decades the rate has ranged between 10 – 20 billion barrels per year. To put that amount in perspective it’s roughly half of what we currently consume. The cost of oil exploration has dramatically increased as it is becoming more challenging and risky. Now these are mainly conventional sources of oil. Unconventional oil (ie. oil sands) are becoming an increasing part of the production mix; however, many of these are already known resources and it is simply a matter of improving the extraction technology or waiting until gas prices get higher enough to make them financially attractive (but see point 2 above).

Conclusion: MYTH. Discovery is becoming more expensive, complicated, and has reducing yields.

And what fact makes these cheap-gas arguments irrelevant?

China.

Yes, fuel efficiency standards will abate U.S. fuel demand, albeit gradually.

Yes, technology will improve and we’ll be able to extract more from known reserves.

Yes, we will continue to find new reserves, albeit at an insufficient and declining rate.

But China’s increased demand for oil will dwarf these.

Car ownership versus GDP for 2000 and 2050

A plot of car ownership as a function of nation wealth, showing 2000 actuals and a 2050 projection. Note China and India. Extracted from Chamon et al, International Monetary Fund. The implications of mass car ownership in the emerging market giants.

Personal vehicle ownership has always piggy-backed on a nation’s wealth. All nations that have become developed have followed a similar S-curve of vehicle adoption. Supported by public policy or not, the curve is similar. At a per-capita income of about $4,000USD/person the curve starts to rise, and rises rapidly until approximately $20,000USD/person, and then rises slowly after that. At just under $50,000USD/person the U.S. has a vehicle adoption rate of almost 800 vehicles per 1000 people. For Canada the numbers are ~$43,000USD/person and 600 vehicles per 1000.

And China? About $9,000USD/person and 85 vehicles per 1000. Or said differently, the vehicle adoption rate is one tenth of the US adoption rate. Fun fact: the adoption rate in China is growing so rapidly that is has already taken the spot as the largest auto market in the World. China took that title 4 years ago, and is widening their lead every year.

Putting everything into context, the impact of China going from 85 to 95 vehicles per 1000 equivalent to the sum of three Canada’s. The current estimate is that by 2030 China will have 230 vehicles per 1000 people. All drinking the same fuel the cars from the rest of the World are drinking. So now you can see why making our cars 30-50% more efficient or adding 6 months of global oil supply ends up being just noise, when we look at it from a global oil supply/demand perspective.

If the cheap gas debate was a tug of war, the cheap gas side has three pre-pubescent teenagers awkwardly tugging on the rope with smartphone-toned arms. The expensive gas side has a behemoth, with muscles forged from years of desire and Chuck Norris determination ripping away at the other side of the rope. The game is rigged. The outcome is obvious.

Napoleon said, “China is a sleeping giant. When she awakes, she will shake the world.”

So the next time someone asks my least favorite question, my answer will be “Because she’s awake. She’s about to shake the world’s gas prices. I hope you’re ready.”

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  • Stephen Bieda

    I like your argument. To further hammer home the point about $5 gas, we are now 30+ years past peak oil per capita (1979). Not only is there a resource extraction issue at hand, but a population growth problem as well.

  • jstack6

    The US subsidies OIL and has for 50 years so the prices are lower at the pump.
    Fracking is what had kept prices lower. They are killing our water supply to suck oil and NG. The use hit peak NG in 2004 and started importing a lot from Canada. Then with Fracking they want to sell the excess that have. It is so short sighted.